The Markets May 11, 2017

Generating Income Tops Adviser Concerns

Most advisers are optimistic about equity markets and believe the Trump administration will have a positive impact on their business, but pessimism about the bond market prevails.
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Advisers’ focus on generating income has reached a record level, according to Eaton Vance’s Advisor Top-of-Mind Index (ATOMIX) results for the second quarter of 2017. That figure rose 16% in importance compared to last quarter’s survey, reaching its highest income ranking of 125.8 to date.

The overwhelming majority of advisers (95%) believe the Federal Reserve will raise interest rates at least once more in 2017. More than half (56%) predict at least two additional rate hikes this year. And 52% of advisers report planning to be bearish on the U.S. bond market throughout 2017, while only 18% plan to be bullish. However, they are relatively more optimistic on municipal bonds, with 32% bullish and 23% bearish on the muni market.

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The survey also dug into how advisers are adapting as political battles unfold. The majority of advisers believe that the administration of President Donald Trump will have a positive impact on the stock market (76%), the U.S. Dollar (62%), their own businesses (80%) and their personal income (79%). But the overall political environment in the nation is fueling concern, with nearly half or 49% of advisers believing it will be the main driver of market volatility this year.

One particular political arena advisers are keeping an eye on is, of course, tax reform. Although the survey finds tax concerns rated lowest on the ATOMIX at 86.4, it saw a 20% increase over Q1 2017.

Still, nearly two thirds (64%) believe the Trump administration will have a positive effect on taxes over the next four years. Nonetheless, 54% are likely to modify their clients’ investment strategies as a result of expected tax policy changes.  

“The political environment initially buoyed markets in early 2017, but the continued low rate environment combined with a longer term bearishness on the bond market has pushed advisers to more closely examine client income opportunities,” says John Moninger, managing director of retail sales. “While current equity market sentiment is generally positive, advisers have trepidations about what lies ahead, including the potential for rising rates and policy changes and the resulting impact on the equity and bond market.”

To defend against the consequences of such outcomes, advisers are adjusting client portfolios. Fifty-five percent of advisers believe floating rate loan funds are the most attractive option in a rising rate environment and are incorporating them into client portfolios. Another 53% of advisers are looking to dividend-paying stocks to offset rising rates. High-yield-bond funds (38%) and multi-sector bond funds (29%) are also favored strategies in a rising rate environment, the survey found.

As for volatility as a concern, the figure marginally decreased to 111.5 on the index after reaching a peak of 129.7 in the third quarter of 2016. More than half (53%) of advisers reported being bullish on U.S. equities over the next year, while only 20% were bearish. When asked if clients were motivated by fear or greed, 55% of advisers reported fear as the top motivator. While seemingly high, it marks a significant decline from a high of 82% motivated by fear in August 2016.

And despite ongoing optimism in the equity markets, nearly two in five (39%) advisers believe markets are overvalued while only 7% believe the market is undervalued. 

The index also gathered some insight into growing investing trends. For example, the importance of socially responsible investing has increased dramatically quarter over quarter among both advisers and their clients. Two in five (40%) advisers reported it as an important part of their practice, signifying a 90% increase from Q1 2016 when only 21% believed the same.

“The rise in popularity of responsible investing is something we are watching closely,” says Moninger. “Advisers are telling us they are hearing more about it from their peers, their clients and in the media. We are developing educational materials and solutions to address these needs in ways that meet investor objectives.”

The Markets May 11, 2017

Fixed-Income Holdings Can Make Or Break TDF Performance

J.P. Morgan’s head of target-date strategies urges plan advisers to reexamine the “critical role of fixed-income assets in target-date funds,” highlighting ways they can help clients generate stronger risk-adjusted returns and manage volatility.
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The fixed-income allocation is often the key differentiator among target-date strategies that appear similar in terms of equity holdings and the basic glide path strategy, according to a new analysis from J.P. Morgan Asset Management.

In a new retirement insights paper, “Three Questions for Assessing TDF’s Fixed-Income Allocation,” Dan Oldroyd, portfolio manager and head of target strategies, argues fixed-income investments play a crucial role in overall target-date fund performance. However, he commonly sees clients and industry professionals alike focusing much more on the equity holdings in TDF portfolios—perhaps based on the assumption that this part of the portfolio is always the greater source of risk and returns.

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This is simply not true when one keeps in mind the very long-term nature of TDF strategies, Oldroyd warns, especially when one remembers that any given TDF may start out mainly allocated to equities—but over time the fixed-income allocation takes the lead role. Especially for investors near the retirement date, the nature of a TDF series’ fixed-income holdings can make all the difference.

“The fixed income allocation can be a key differentiator among target-date strategies, but its structure and management do not always get the attention they deserve within the TDF selection process,” Oldroyd adds.  

He points out that preferred TDF strategies may vary quite widely across plan sponsors based on participant needs, and that when selecting the best TDF for their unique participants, plan sponsors should consider three things. First, is the fixed-income portfolio sufficiently diversified? Next, does the fixed-income manager have the flexibility to enhance risk-adjusted returns? And finally, can the TDF’s fixed-income portfolio help weather a rise in interest rates or other changes in the economic and investment environment?”

Oldroyd observes that most investors understand the basic idea that a well-diversified equity allocation may be able to deliver more consistent risk-adjusted returns across a wider range of investment environments than a more narrowly diversified, concentrated allocation. Yet fewer people seem to grasp that the selfsame factors apply to the fixed-income markets—that there are many different types of bonds holdings one can purchase, and many different ways to organize them in pursuit of the efficient investing frontier.

And just like on the equities side, the J.P. Morgan analysis goes on to argue that “skilled active fixed-income managers generally have greater flexibility and more tools than passive managers for generating strong risk-adjusted returns over time. Replicating a fixed-income index can be more complex, costly and subject to structural bias, and involve more active decisionmaking, than some investors realize.”

Concluding with some important context, Oldroyd suggests that interest rates are widely expected to climb higher during the rest of 2017. And so retirement plan investors “should ensure TDF strategies can adapt to such changes and represents a reasonable compromise between controlling costs and providing participants with the potential for a smooth path to a financially secure retirement.”

Additional research and information from J.P. Morgan Asset Management is available here.

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